The Securities and Exchange Commission approved a plan Wednesday to overhaul regulation of money market funds, which are some of the biggest buyers of asset-backed commercial paper (ABCP).
The proposal is intended to safeguard these funds from the kind of run by investors that occured in 2008, when shares of a major fund fell below $1, or "broke the buck," as the result of s exposure to debt issued by Lehman Brothers. In the days that followed, nearly $200 billion was withdrawn from prime money market funds - about 10% of the sector's invested assets. This led to severe funding pressures for issuers of commercial paper.
The SEC’s proposal calls for two alternatives. The would be to require institutional prime money market funds to allow their net asset values (NAV) to float, rather than hold at $1 a share. This could limit the appeal of money market funds, since certain kinds of institutional investors are subject to guidelines or restrictions that discourage or prevent them from using floating NAV products to manage short-term cash holdings.
Typically, MMFs strive to keep their share prices stable at $1; if they drop below this level, managers typically step in to provide support, figuring the cost of lost customers and damage to their reputation outweigh the costs of a bailout. In 2008, the Reserve Primary Fund's failure to support its share price sparked widespread panic until the U.S. Treasury stepped in to provide insurance.
The second alternative would permit money market funds to continue transacting at a stable $1 share price, but would require them to impose a liquidity fee on redeeming investors in the event the fund’s liquid assets drop below 15% of its total assets; however a fund’s board could opt not to impose the fee if it determined that this was not in the fund’s best interest.
Under this alternative, a fund’s board would also be permitted to suspend redemptions temporarily — that is, to “gate” the fund — if the 15% liquidity threshold is crossed.
The SEC will consider whether the two proposed options will eventually be combined in the regulation eventually adopted by the agency, or whether the agency chooses just one of the reforms in a final rule. The agency will take into consideration the feedback it receives over the next three months.
Each alternative calls for several significant disclosure enhancements, such as requiring a fund to disclose any sponsor support it receives, to disclose its liquidity in more detail, and to disclose additional information about its portfolio holdings.
Other disclosures would explicitly warn that investors can lose money when investing in a money market fund. Under the fees and gates alternative, although a fund’s NAV would not float, a fund would have to disclose its market-based “shadow” NAV on a daily basis, a practice that many funds have already begun.
Wednesday's proposal did not inclue the requirement of a capital buffer to absorb fund losses; this was one of the options recommended by the Financial Stability Oversight Council.
The Investment Company Institute (ICI), a trade group for mutual funds, said in a press release today that it was particularly pleased that the SEC recognized the effectiveness of liquidity fees and gates in addressing risks that might arise in a widespread crisis. It also welcomed the inclusion of fees and gates as a standalone option in the proposal.
“As we have long maintained, any proposal to make money market funds even more resilient must be judged against two principles,” said Paul Schott Stevens, the group's president and CEO
“First, changes must preserve the key features of money market funds that have made them so valuable to investors and so important to the businesses and state and local governments that rely upon these funds for financing. Second, changes must preserve choice for investors by ensuring a continued robust and competitive global money market fund industry.”
A spokesperson at the ICI said that it was still too early to determine what impact the new rules could have on money market fund's investments in ABCP.